The British fiscal package only works if the world economy starts to recover in the second half of next year and continues to grow strongly from then onwards. So will it?
The balance of probability is that, yes, 2010 will probably be a better year than 2009; but no, the recovery won't be a strong one here or anywhere else. The prospect is for a long pull, not a swift bounce. If that judgement proves right, then our UK policy will prove wrong.
To say that of course is to make a breathtakingly broad judgement and you have to take it with a health warning in block capitals. But I think there are things that can sensibly be said about the likely path of this downturn from our experience of past ones.
No cycle is exactly the same, not just because the timing and depth varies but because each has special characteristics. Thus the bust that followed the dot-com boom of the late 1990s was different from the bust we are experiencing now. Both were associated with asset bubbles. But this bubble has been more widespread and hence more damaging.
While the policy response around the world may help or hinder the recovery, there is clearly a natural cycle in the world economy from which we seem unable to escape.
That has both bad and good consequences. The bad one is that neither we nor other national governments can magic away the pain. The good one is that all our past experience is that the world economy is self-healing. Only truly destructive policies by governments, such as were deployed in the 1930s, can wreck the recovery completely.
We are not going there. That is partly because we have learnt our lesson but also mercifully because the hatreds and stupidities of that dreadful period are barely evident today.
Nor, I think, is this cycle likely to be as serious as those of the 1970s and 1980s, though this is possible. The reason for that judgement is that during that period the major governments lost control over inflation. That threatened the very fabric of the market economy, bringing the threat of social breakdown as well as economic disruption.
We had a pretty bad bout of both in the UK but similar pressures were evident elsewhere. These were brought about in part by inflation itself, which disrupted relations between the various parts of society, and in part by the only mechanism effective at crushing inflation, high interest rates. That battle was won and the early 1990s recession was less serious than the previous two.
The early 1990s provide the best template for what is likely to happen now. As far as the UK is concerned there is the particular parallel of a collapse in house prices, where things fit pretty well into the pattern then. For the world as a whole the early 1990s work quite well as an example of a middle-sized recession, not terrible but not much fun either.
In saying that, though, I have to acknowledge that the financial markets do now seem to be discounting something worse. That has, I think, more to do with the extreme financial disruption that is still happening, rather than reflecting a considered view of the prospects for the world economy, but that could be wrong.
Looked at globally there are two causes for optimism and one for pessimism. The two optimistic ones – why this downturn will not be any worse than the 1990s – are that the policy response around the world has, after a slow start, been strong, and that the emerging economies seem likely to continue to deliver some growth. The pessimism comes from the fact that financial disruption still has some way to go.
The two most important countries, as far as economic policy is concerned, are, of course, the United States and China. Between then they have been supplying some two-thirds of all the additional demand in the world. Both are now switching to a strong growth impetus.
We know that the new American President wants to bring in a fiscal boost and we know that the banking system is being recapitalised. In China there has already been a range of new policies designed to beef up domestic demand. The Chinese had rather shut down the economy in preparation for the Olympics. Cranking it up again has proved tougher than they had expected.
But while we shouldn't be too hopeful of a swift recovery next year, given the scale of what the US seems likely to do and given what China is doing, there should, by the end of next year, be some recovery to growth in the US and reasonable (though slower) growth in China. The principal reason for concern is that the financial disruption that has spread through the world is still not over. It won't be over until asset prices have fallen to a level that everyone can respect as a base. That has not happened yet.
Take US house prices, where the problem began. Yesterday there was a report that prices in the 20 top American cities were still falling and at the fastest pace on record. The reason is the flood of foreclosures. Until all these houses have cleared through the market there won't be a base and until that happens all the mortgage securities swishing around cannot be priced.
The same goes for all the other complex derivatives that the US mathematicians dreamt up. And until that happens, confidence will not come back to the banking system. Eventually all this moves through the system but it could be a year, maybe even more, before it does. Meanwhile there is more stuff to happen.
But let's assume these various factors will cancel each other out and this will be a bit like the 1990s. What does that mean for us?
Then the UK had a relatively serious experience, with the economy falling by 2.5 per cent from peak to trough. That was rather greater than the Treasury is forecasting for us now. Our problem then, aside from having permitted the housing boom, was that as members of the Exchange Rate Mechanism we had to hold the pound in line with the deutschmark, which meant interest rates which were far too high. This time we have dropped rates and allowed the pound to fall – it has actually fallen by more now than it fell then.
If we follow that path, there could be some growth in 2010, though maybe not starting in the second half of 2009 as the Chancellor hopes. But it is hard to see there being strong growth from 2011 onwards and if that does not happen, then all those terrifying high borrowing projections would be, well, even more terrifying.
There is an internal inconsistency in the Government's position. It is saying this is an unprecedented situation warranting unprecedented action, yet their own forecast suggests something less serious than the early 1990s dip. It doesn't wash.